Ukraine's President Petro Poroshenko.REUTERS/Edgar Su
The Ukraine economy is on the brink of collapse after the International Monetary Fund identified a $15 billion shortfall in government funding that will need to be plugged "within weeks," according to the Financial Times.

The shortfall comes after Ukraine's gross domestic product fell by 5.3% in the third quarter of 2014, the State Statistics Service reported Wednesday, as the country lurches from crisis to crisis. Ukraine's GDP also dropped 4.7% in the second quarter and saw a 1.1% contraction in Q1. In short, the country is in deep trouble.

Analysts are predicting a total contraction of about 7% through 2014, and the country looks set to continue its decline next year. This sharp contraction comes at an unfortunate time for the country, just before it is set to hand over $19 billion over the next three years ($7.5 billion in 2015, $4.7 billion in 2016, and $6.6 billion in 2017) in debt payments.

Under IMF rules, the fund is not allowed to provide capital to a donor country, even if it has already been pledged, unless it is confident that the country can meet its financing obligations for the next 12 months. This means the bailout is on hold until donors sign off on the increase in funding — but the desire for such a large increase is sorely lacking.

In fact the country's recovery could still be years away, according to Bank of America Merrill Lynch.

"In the scenario of stabilization, the recovery is likely to start only in 2017 and we project growth to be around 3-4% in 2017-19, close to its potential level. In this scenario, the debt-to-GDP ratio would rise further but would stabilize below 90% in 2017-19E, if fiscal consolidation reforms continue and UAH devaluation slows."

That is, assuming that the ongoing conflict with pro-Russian rebels in the east of the country doesn't intensify and that the fragile new government is able not only to announce but also to implement thorough economic reforms and clamp down on corruption, then the economy might — just might — start to grow again at a modest pace in 2017. This is a world away from the optimistic scenarios for Ukraine that supporters of the Maidan protests in Kiev envisaged at the start of the year.

Ukraine debt-to-GDP.Bank of America Merrill Lynch
So what went wrong? The IMF has pledged $17 billion of funding for the country, and other donors have also chipped in with pledges of another $10 billion, of which Ukraine has received $8.2 billion. This was deemed sufficient to ensure that the immediate funding needs of the country would be met and, once the country had stabilized government debt (which leapt up from 40% of GDP in 2013 to about 70% this year) would be left on a sustainable footing.

These forecasts now look wildly optimistic. The government in Kiev has effectively lost control of regions accounting for some 16% of Ukraine GDP to rebels, while the costs of fighting continue to mount.

And now the country is running out of money.

In response, Ukraine's central bank has been forced to burn through its foreign-currency reserves to meet government spending commitments as the economy struggles. Last week it announced that reserves had fallen below $10 billion, its lowest point in a decade, according to The Wall Street Journal.

The situation is now hitting crisis point.

Finance ministry officials from G-7 countries met last week to decide upon a new $4 billion loan package for Kiev, but doubts linger over the ability of the new government, which took office only last week following elections in October, to deliver on its commitments. Any new money is likely to be made conditional on the swift passing of a new budget due Dec. 20 that is likely to require significant spending cuts.

Such is the scale of the problem that European Union ministers were reported to be considering petitioning Russia to roll over its $3 billion loan to Ukraine, despite EU sanctions against the country over its role in supporting the rebels.

One possibility being floated is that Ukraine be allowed to begin negotiations to restructure its debts (that is, seek forgiveness of some of the debt) coupled with any new injection of funds. That way the debt sustainability question that is a potential huge stumbling block to the IMF program would at least be resolved, even if it comes at a cost to those holding Ukraine government debt.

So far there has been predictably strong resistance among bondholders to this idea, but they may be on the wrong side of the argument. After all, getting some money back from Ukraine in an organized manner is better than getting nothing in the case of a sovereign default.